March 18, 2011

Student Finance: Bias at the BBC?

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According to a new report on the BBC website, headlined in last night's BBC TV and Radio news, "Graduates 'could pay back double their student loans."

It sounds scary. I can see another few hundred families around the country listening to the news and deciding university sounds just too expensive.

That would be a shame. There is a story here, but it is not the story on the surface. It is a deeper story, one of distortion and misrepresentation.

  • First: There is nothing new in this "news."

Anyone who borrows will eventually repay more -- mechanically adding up the cash amounts, year after year -- than they borrowed. Interest charges ensure this result. Moreover, the longer is the period over which you borrow, the greater is the excess of cash repayments over the initial loan. 

But why do borrowers pay interest? Because not having to wait is valuable. This has an important implication. A pound today is worth more than a pound next year or the year after. When you take out a loan, you've made the calculation that it's better to have the house or car now than wait for years in rented accommodation or sharing public transport while you save up. It's better to borrow and buy despite the fact that, having borrowed, you will have to repay more later.

By the same argument, the money you will have to repay next year should be considered worth less than the same money now. This is called discounting: we discount the future compared with the present.

Because future money has to be discounted to find what it is worth today, it is wrong to add up money in different periods without adjustment. Rather, the future values should be discounted, year by year, before they are added up.

Imagine the following scenario. In the BBC's story, the graduate has a debt of £43,000. In my scenario, you decide to borrow the same sum, but as a fixed rate mortgage, not a student loan. Suppose the lender's interest rate is 3 percent a year. Suppose you repay the debt in full, in equal annual instalments over 30 years.

On these assumptions, the sum of your undiscounted cash-out repayments will be a little over £67,000. But, if we revalue your payments in every year by discounting them back the present at 3 percent annually, the present value of the sum of your discounted repayments will fall to ... oh, £43,000.

The present value of the repayments is the same as the value of the loan!

  • Second, therefore, there is no story. You repay -- in present value -- exactly what you borrowed

But wait. That leaves a puzzle in the BBC account.

Remember that, in my example, you repaid everything at the market interest rate, and yet the undiscounted sum of your cash-out repayments was just £67,000, compared the £43,000 borrowed. 

Compared with that, under the government's student finance proposals, graduates will enjoy three concessions. They'll repay nothing, and accrue no interest, while their salaries remain below £25,000. Between £25,000 and £41,000, they'll pay a reduced interest rate. And anything outstanding after 30 years is forgiven. Under those assumptions, surely, graduates should end up repaying less than you?

Yet, in the BBC version, graduates have to repay much more than you. The BBC puts the sum of undiscounted repayments at sums varying between £72,000 and £84,000, depending on the income of the graduate. It's the latter figure that lets them claim: "Graduates 'could pay back double their student loans." 

What's going on?

The BBC commissioned "leading accountants," including the firm Baker Tilly, to support this story. It's based on a spreadsheet, available from the BBC website, "showing the calculations." The spreadsheet shows that the BBC's accountants sneaked in a hidden assumption, not reported in the story.

They built in 2 percent yearly inflation. In each year, they added 2 percent inflation to the repayment thresholds, 2 per cent inflation to the graduate's salary, and 2 percentage points to the interest paid.

What's wrong with that? Nothing -- except this: The 2 percent inflation assumption also pumps up the nominal undiscounted cash sums that their graduate repays every year. That was how they made the figures support that scary headline: "Graduates 'could pay back double their student loans."

Inflation is a further reason why it's wrong just to add up the column of annual cash repayments. Except in the first year, the annual payments are not in present-day prices. They are in different prices of different years, all of them higher than today's and some of them much higher. It's just plain wrong, and misleading, to lump them all together.

The BBC's calculation should have been done throughout in constant prices, so that the purchasing power of £1 would be the same in every year. But, if done at constant prices, there would have been less of a story. After proper discounting, there would have been no story at all. In fact, it would have emerged that:

  • Most graduates will repay less, in present values and constant prices, than they borrow at the outset.

This brings us back to "the leading accountants." Given who they are, I guess they know their stuff. But do they? The mess behind this story leaves only two possibilities. They understood these issues perfectly well when they made their calculations -- or they didn't. 

Either way, it looks bad for the accountants. Incompetent, or colluding with a misleading agenda? I'll leave it to you to decide on that. 

It looks bad for the BBC, too. Remember, this is not the BBC reporting the news. It is the BBC inventing the news. 

  • Finally, a note for readers interested in open-source data.

The BBC website provides the spreadsheet with the figures, in their words, "showing the calculations." That's good.

The problem is that, before uploading the spreadsheet, they converted all the spreadsheet formulae to values. It is the formulae that enable to user to track the links from one number to another, and see at a glance how the calculations were made. The truth is that the spreadsheet does not show any calculations at all, only numbers. That's bad.

I can see no purpose in it, except to make checking more difficult.

- 5 comments by 1 or more people Not publicly viewable

  1. stephen lamb

    Thanks for this Mark. Really useful information at occasions such as Open Days.

    21 Mar 2011, 10:07

  2. Benjamin

    Hello Prof. Harrison,

    I have the following general remark to make, it applies to this Blog as well as to (many of) your research articles. But first I should say that I really appreciate your research topics and enjoy reading the articles. Unfortunately you seem almost never to take into account that all human beings are not only economic agents but also inert beings with the primary goal of survival. This inertia should lead to different equilibria, more in line with reality. Applied to this topic: Educating citizens is vital to every society not based on forced labour and selling raw materials. The surplus generated by those citizens greatly overcompensates the cost in most disciplines of the academia (it certainly does so in mathematics, engineering and natural sciences). If you privatize the cost (which is what the BBC is basically reporting) totally, you are adding a resistor to the decision process (in favour or against academic studies). This will certainly diminish the number of graduates (while not significantly increasing the quality) due to the inertia (e.g.). It is not clear at all that this policy will pay off in the end. In conclusion I think one needs a far more complicated model to make such descisions on a scientific base.

    Just a final remark. You will certainly agree that lowering taxation of the wealthy contributes to investment in the economy. The reasoning behind this is to optimize the payoff from economic growth. There is no “justice” or any other logical reason behind this. So why don’t you apply the same “logic” in the case of Education?

    Best regards

    PS: You may excuse bad english as I’m not a native english speaker.

    21 Mar 2011, 16:27

  3. Mark Harrison

    To Benjamin: I agree that people tend to be risk-averse, and this make make them reluctant to pay for higher education, taking into account the uncertain difference it makes to earning power. That is a good reason for the British government to take some of the risk out of paying for higher education, by making repayments income contingent.

    Yesterday’s Observer carried extended reports of Saturday’s demonstrations against public spending cuts. Robin van Mickwitz, a student, 19, from Huddersfield, is quoted as saying: “I want to study engineering in a few years and I know I’m not going to be able to afford the tuition fees.” In other words, this is someone that has been taken in by scare stories in the British media about student finance. He doesn’t realize that, under the scheme being put in place he won’t have to find a penny, unless and until he can afford it.

    A powerful middle class lobby is in action that wants to keep taxpayer funding of tuition costs. This is an issue of social justice. People should receive the benefits and pay the costs that follow from their own choices. I agree that “The surplus generated by those citizens greatly overcompensates the cost in most disciplines of the academia.” That is not the point. The point is that the graduates already receive most or all of the surplus as private income. If the benefits are private, why should we socialize the costs? It’s not fair to the millions of taxpayers who either haven’t been to university or earn less than a graduate salary.

    For the same reason, the purpose of public finance should not be to subsidize investment at all costs. That is how the Soviet economy was organized, and I don’t think we want to go there again …

    28 Mar 2011, 11:51

  4. Benjamin

    Of course it is valid to point out if someone is scared away from studying by false, incomplete or misleading information.

    I’m not advocating that investments which contribute to someones personal wealth should be subsidized by the government. I’m rather saying the investment should subsidized if the public sector recieves a substantial share of the payoff afterwards, which would be more than just the repayment of the tuition cost. There can still be a win win situation if it is implemented in the right way (while not suffering lower numbers of students and subsequent lower numbers of graduates). You also wouldn’t have to introduce another decision problem of when someone can afford to repay the debt. I admit that this is still just guesswork since it is still not clear which of the two possibilities yields the bigger share for a society since it is possible for ex. that some graduates could leave the country without contributing anything after graduation (but this could be handled as a special case for ex. by demanding a full repayment in this case with acceptable payments by installments). But we can try to evaluate it by looking at the various education systems implemented across Europe (where both possibilities are present to some degree).

    28 Mar 2011, 19:28

  5. Benjamin

    I’d like to remark further that I don’t think this issue is about fairness. It should be (and I indeed think it is) about what is best for the society a a whole.

    I have to admit that I’m somewhat puzzled why you mentioned fairness. It is also not fair why I indirectly have to pay the 10 mio € salary of Josef Ackermann in the year of the crisis 2009 (via my tax payment) but I’m told that it is necessary because Germany needs those capable overperformers to run its economy. I have the same issue with the property taxation. As far as I understood it market economies aren’t about fairness in general and within such an economy the government is just another agent and therefore should be (if it is supposed to fullfill any welfare duties; otherwise it should of course minimize its costs for the economy) obliged to maximize its outcome while meeting several contraints to keep the society (and therefore the economy) intact.

    28 Mar 2011, 19:49

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I am a professor in the Department of Economics at the University of Warwick. I am also a research associate of Warwick’s Centre on Competitive Advantage in the Global Economy, and of the Centre for Russian, European, and Eurasian Studies at the University of Birmingham. My research is on Russian and international economic history; I am interested in economic aspects of bureaucracy, dictatorship, defence, and warfare. My most recent book is One Day We Will Live Without Fear: Everyday Lives Under the Soviet Police State (Hoover Institution Press, 2016).

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